Electronic exchanges, implemented as Electronic Communication Networks (ECNs), are often used as trading systems to electronically trade a wide range of commodities, stocks and/or other items having real world significance. An ECN normally receives messages, e.g., an order from a trader, performs a matching operation, and if a matching order exists, performs a trade. The resulting trade is reported to the traders which placed the matching orders and also to a public system, e.g., for updating published information about the current price of a stock, commodity or other item being traded on the exchange.
Electronic trading on an electronic exchange allows for large numbers of orders to be stored, processed, and executed at relatively low cost. The speed at which a trade can be executed is important to many businessmen trying to obtain a split second advantage over another trader.
A risk with high speed trading is that as part of the rush to place a trade, a trader may improperly enter an order or will not satisfy some other order constraint. Currently, it is generally a broker's responsibility to check that orders placed by the broker's clients for which a broker is responsible comply with trading rules.
To perform risk checking a broker risk checking system normally checks the order placed by a trader against information the broker has about the trader's position, e.g., what shares the trader owns, the trader's margin, etc. For example, a trader may be precluded from selling shares the trader does not own or placing orders exceeding the trader's available credit with the broker.
The information used by a broker to check orders prior to placing them may involve confidential information about the trader's position which is known to the broker but is intentionally kept secret from the electronic exchange for confidentiality reasons, e.g., for fear that the information will be used by other members of the electronic exchange to the trader's disadvantage.
Brokers are often pressured by traders to implement trades as quickly as possible. For large customers, a broker may feel pressured to skip some or all of the normal risk checking process to avoid processing delays associated with risk checking. While skipping of risk checking on orders, sometimes referred to as “naked trading” can speed up the placing of an order, the risk to the exchange of improper or completely incorrect orders can be considerable and, in some cases, may result in one or more trades having to be unwound. This has the potential for creating market instability which is not in the interest of the exchange.
In view of the above discussion, it should be appreciated that it would be desirable if at least some checking of orders was routinely performed prior to execution by an exchange. From the exchange's perspective it would be beneficial if all or some of the risk checking function was performed in such a way that the exchange could be sure that the checking was performed. It would also be desirable that brokers were not given the opportunity to avoid at least some risk checking for some clients, to give them a trading speed advantage, relative to clients of other brokers.